EZCORP - Significantly Undervalued Or Value Trap?

Summary

The US business is undervalued compared to prices paid in private market transactions.

Accounting issues in Mexican subsidiary have little impact on US business.

Corporate governance issues might make this situation a value trap.

EZCORP (NASDAQ:EZPW) is a provider of pawn and consumer loans via brick and mortar stores in the US and Mexico.

Share price

$3.10

Shares out (A+B)

54.8949mln

Market Cap

$170mln

Click to enlarge

The share price has come down significantly over the last years for multiple reasons.

Profits from jewelry scraping have come down along with falling gold prices.

New regulations on payday lending in the US and UK have rendered the business unsustainable.

Accounting irregularities in Mexican subsidiary.

Controlling shareholder had a $7mln consulting contract revoked by management (NASDAQ:GOOD) but in turn he had them fired a short while later (bad).

The stock looks interesting because:

Based on private market transaction since 2013 pawn stores trade at ~6x outstanding pawn loan balance and ~$2mln per store. On that measure the US business alone should be worth $1,000mln.

Off the 356mln of debt only 230mln are recourse to EZCORP. The debt in the Mexican entities is non-recourse to EZCORP.

Management guides to a normalized EBITDA for the US Pawn business of $107mln. Cash America (NYSE:CSH) (US pure play) trades at 9.6x, First Cash Financial (NASDAQ:FCFS) (US+LATAM) trades at 11.2x. Applying the lower 9.6x multiple on $107mln gives EV of 1,027 or an equity value of $797mln after deducting the debt ($14.50 per share).

EZPW owns 32% of Cash Converters which is currently worth ~64mln.

But the view that management is trying to paint is clouded by corporate expenses that are not attributed to the segments. Under corporate items there are $73mln of administrative costs mentioned. Administrative costs are executives and administrative costs including salaries, stock and incentive compensation.

As long as the US business is not sold the costs need to be included in my opinion. Deducting the costs from normalized segment EBITDA and adding the value of the stake in Cash Converters (ASX: CCV) results in a value of $2.91 per share.

As of the last call management is aware of the problem of high administrative costs. Nevertheless costs don't seem to go down but up (10-Q Dec 2015: administrative costs $19.9mln vs 12.6 prior year and operation expenses $85mln vs 80).

Bullish Case

Administrative costs were $44thsd per store before 2014, currently costs have doubled to $88thsd. If corporate costs fall back to $44thsd after the restructuring of the business total administrative costs would be $37mln instead of $73mln. This translates into EBITDA of $70mln or at 9.6x multiple ~$12 a share including CashConverters.

EBITDA of $70mln equals an EBITDA margin of 11.6%. Competitor CSH currently generates an 11% adjusted EBITDA margin. So this seems plausible. $12 a share would mean 288% upside.

Bearish Case

The business goes bankrupt, Mexico is closed down. The US business is sold off. The pawn business is a regulated business and requires a license to operate. So even if run unprofitably there is more value to a pawn store than only tangible assets. Equity holder would lose if US stores would be sold below 2.1x outstanding loan balance. That's 1/3 of what is usually paid in the private market. I am not an expert in bankruptcy proceedings but it would surprise me if bankruptcy court would sign off on a fire sale like that. Anything above 2.1x would be beneficial to the shareholder. Another way to look at it would be that the loan balance could fall 2/3rds before shareholders would incur a loss in a sale at 6x multiple.

No catalyst in sight

EZCORP is controlled by Mr. Cohen who controls all outstanding voting shares while only commanding an economic interest of 11% in the company. Activist investor involvement is therefore unlikely. Also in light of issues around the $7mln consulting fee paid to Mr. Cohen it is not really clear whether his interests and those of shareholders are aligned.

Disclosure:I/we have no positions in any stocks mentioned, but may initiate a long position in EZPW over the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This article does not constitute investment advise. I might initiate, add, reduce or liquidate the position at any time without giving any notice. Please do your own research.